Since the Supreme Court’s landmark ruling last year in AT&T v. Concepcion, companies have increasingly adopted mandatory arbitration agreements that require employees to settle disputes outside of court. However, a recent 5th Circuit decision put some limits on businesses’ ability to do this.

In Carey v . 24 Hour Fitness USA Inc., the court ruled on Jan. 25 that it is fundamentally unfair for two parties to “enter into an agreement that ostensibly binds them both, but where one party can escape its obligations under the agreement by modifying it.” Then, applying this principle to the arbitration clause contained in the 24 Hour Fitness employee handbook, the court held that the clause was illusory and unenforceable.

In January 2005, during the term of John Carey’s employment with 24 Hour Fitness, he received an employee handbook and signed a form acknowledging that he had received the handbook. The form said, “I acknowledge that, except for the at-will employment, 24 Hour Fitness has the right to revise, delete, and add to the employee handbook. Any such revisions to the handbook will be communicated through official written notices approved by the President and CEO of 24 Hour Fitness or their specified designee.”

One handbook section stated that all employment-related disagreements would be “resolved only by an arbitrator through final and binding arbitration.” The handbook explicitly identified Fair Labor Standards Act (FLSA) claims as being included in the mandatory arbitration policy. The policy also specif ically claimed that the Federal Arbitration Act (FAA) would govern the provision, and that it prohibited class actions. In addition, the acknowledgment form Carey signed restated the requirement that disputes be submitted to binding arbitration.

After Carey’s employment ended (no court opinions disclose how Carey came to leave his job), he filed a class action claiming that 24 Hour Fitness failed to appropriately pay him overtime. 24 Hour Fitness asked the court to stay its proceedings and force Carey to submit his claim to arbitration as the employee handbook mandated. Carey argued that the arbitration clause in the handbook and acknowledgment form was illusory because 24 Hour Fitness retained the unilateral right to amend the agreement. The district court refused to stay the proceedings, and 24 Hour Fitness appealed. But the 5th Circuit agreed with the district court and held that because the employer had the unilateral, unlimited right to amend the agreement, it was not contractually binding and was unenforceable.

Key Difference

The court explained that the key difference between the arbitration clause at issue in this case and clauses held to be enforceable in previous cases was the unlimited nature of the right to amend the handbook. The language in 24 Hour Fitness’ handbook could be read to include the right to apply new policies to existing disputes. The court said that to be valid, the clause must expressly state that if there is a claim pending at the time the employer modifies the agreement, those modifications will not apply to the pending claim.

According to John Allgood, of counsel at Ford & Harrison, the nuance in this case was whether the employer really had the unilateral right to modify or terminate the agreement. 24 Hour Fitness said it didn’t, because the language of the agreement required it to give notice to employees if changes were made to the agreement. The company argued that if there was a requirement to notify employees, the implication was that the employees had to accept the changes. However, the court rejected this argument.

“In effect, the agreement allows 24 Hour Fitness to hold its employees to the promise to arbitrate while reserving its own escape hatch,” the 5th Circuit said. The court reasoned the arbitration clause could be interpreted so that if an employee tried to force the company to arbitrate a disagreement, 24 Hour Fitness could change the agreement and make the changes apply to the pending dispute.

“You must say to your employees, and they must understand, that amendments cannot be applied retroactively. They can only be applied going forward,” Allgood says.

It is important to keep in mind, Allgood notes, that the underlying facts of this case concerned rights protected under the FLSA and that the company was conducting arbitration under the FAA. In those instances, for an arbitration agreement to be enforceable, it has to protect the remedies available to the employees as if they were in a court of law. “[The court] didn’t say this in the decision, but when I read the decision, that was certainly a concern of mine,” Allgood says.

Be Fair or Beware

Essentially, the court said that employers can’t argue that arbitration clauses are binding when they want them to be and not when employees want them to be. “If the employer has the option to unilaterally change the playing rules depending on how it sizes up the case—good, bad or otherwise for its position—it’s an illusory benefit,” says Mark Tabakman, a labor and employment partner at Fox Rothschild.

Kelly, Hart & Hallman Partner Russell Cawyer notes that most employee handbooks have a disclaimer saying that nothing in the handbook is intended to create any contractual rights. However, he adds, “That’s exactly what an arbitration agreement is; it is a contractual right. So sometimes your contract disclaimer at the beginning of the handbook will undermine what you try to obtain by way of the arbitration agreement.”

Cawyer and the other experts stress that employers must take care with their employee handbooks. Companies can ensure their arbitration clauses are enforceable by separating the agreement from the company handbook and reviewing all materials for any contradictions. “You don’t want to create additional contractual rights by your handbook policies, but you want to make sure the ones you want are contractual in nature and will be enforced, unlike the one in 24 Hour Fitness.”